Decision making is difficult. In the song “Should I Stay or Should I Go” by The Clash from 1981, the narrator doesn’t know what to do and asks us- his listeners – and his anonymous darling for advice “Should I stay or should go?”.
In the context of owning a business, you as an owner or other important stakeholder (board member, management or key individual) will from time to time face a similar question, paraphrased as: should I sell or should I grow? And contrary to the song’s open ending, you might have to make a decision.
For financial side of the decision, there is a simple rule of thumb that can help you.
The logic is simple. It doesn’t matter how you value your company (P/S, P/E, cash flow, P/recurring sales, dividend multiple etc.) If you make the decision now, the valuation method will produce a value. If you make the decision later, the same method will produce another value based on the growth of that valuation factor. If the factor grows slower than the industry risk, approximated by its discount rate, the present value of the factor be lower than its current value.
First, the growth. Assume that you for simplicity value the company based on sales, “Price/Sales” (P/S). Let’s then focus on sales. Next year’s sale is dependent on this year’s and a growth rate. This is captured by the recurrence formula:
For example, assume 5 years. Then each year´s sales will be:
That is, at year 5, the expected sale as a function of this year’s is:
Second, the risk. Assume that the risk is captured by a discount rate. What is the value today of the fifth year’s sale? The present value of is expressed as:
Combined, the formula for the present value shows that the value increases based on the growth rate and decreases based on the discount rate:
Thus, if the growth rate is smaller than the discount rate, you should consider selling since the present value of your valuation factor (e.g. sales) is lower than the current value. Otherwise, continue to grow.
All of this and some decision support axis are captured in this model which you can download from here (to run it you need a CDF reader). In the model, you can experiment with decision time horizons, desired values, growth rates and discount rates. Different scenarios can be saved using the “+” button.
We as listeners never get to know the outcome of the song which might explain the song’s popularity. Being a stakeholder in the decision and leaving the outcome to chance might be comfortable but is not sensible for the business.
For the decision itself, Ablona can help you with determining your industry growth rate, the industry discount rate and with the chance of finding a buyer.
For the sales outcome, Ablona can do the work of selling the company, from positioning, calling and qualifying potential buyers and participating in the negotiations.
For growth outcome, Ablona can help with identifying bottlenecks in the existing business and helping you with potential acquisitions.